Economic Notes – January 13, 2014


Written by: Jon McGraw

(0/-) The ISM Non-manufacturing index came a bit weaker than expected, falling from November’s 53.9 to 53.0 for December (expectations called for 54.7). On the positive side, employment improved by several points, while business activity was generally flat, and new orders and inventories fell by over 6 points each. This isn’t entirely surprising, as services consumption has significantly lagged goods consumption during this entire economic recovery. However, it is improving, as the diffusion index being over 50 indicates positive growth—just not as good as that seen in the manufacturing survey the previous week.

(+) Factory orders for November rose +1.8%, besting forecasts by a tenth of a percent. The underlying data was also generally in line with expectations, with core capital goods orders and shipments revised downward a bit, but strong regardless. Inventory buildup wasn’t as dramatic as it could have been.

(+) While not often an exciting component, the November trade deficit shrunk dramatically to -$34.3 billion versus an expected -$40.0 bil.—its narrowest level since 2009. The difference was largely due to changes in the petroleum balance, which fell by -$1.4 bil. on the month, as well as record U.S. exports to China. Net-net, total exports increased by +0.9% while imports fell -1.4%. While not a dramatic news item most months, this trade balance measure does play a key role in GDP and may have boosted growth by up to several tenths of a percent for the quarter.

(0) Wholesale inventories for November rose +0.5%, surpassing estimates by a tenth of a percent; however, October numbers were revised downward a bit. Outside of the petroleum figures, computer inventories rose +3% and machinery gained just under +2%.

The bulk of the week’s news was jobs-related…

(+) Initial jobless claims for the Jan. 4 ending week fell by 4% to 330k, a positive surprise versus the 335k estimate. Nothing strange was noted—per the Department of Labor who comments on relevant anecdotal happenings—but the holiday/year-end period does tend to be more volatile than average, and this can last through January. The more relevant four-week moving average fell by 10k, which is a positive as well. Continuing claims for the Dec. 28 week climbed a bit to 2,865k, above the 2,850k expected. Of special note, the continuing claims portion doesn’t include any folks covered by the extended unemployment benefits that expired at year-end. In looking at the state-by-state detail provided for the last week of 2013, northern states, such as Michigan and Pennsylvania, experienced greater claims due to layoffs in manufacturing and transportation, while improvements in claims came from California and Texas, where fewer layoffs in service positions helped.

(+) The ADP employment report for December, released on its traditional Wednesday before the big government report on Friday, was stronger than expected, with a gain of +238k jobs compared to +200k expected by consensus. Additionally, the November report was revised higher—from +215k to +229k. Underlying the headline figure, construction employment was a strong point—gaining +48k jobs (highest since early 2006)—while manufacturing and financial activities were up +19k and +10k, respectively. Small business job gains led, with +108k of the total, relative to large- and medium-sized firms. As we’ve mentioned before, the correlation between the ADP and government reports isn’t perfect, due to some definitional and recordkeeping-based differences between the two, but a stronger showing is certainly preferable to the opposite alternative.

(-) The closely-monitored government December employment situation report was a bit of a bust. Only +74k jobs were added in the payroll survey report (the larger survey, which samples 400k business establishments), which dramatically lagged the expected +197k result. The one plus is that November payrolls were even better than first report, as the final number was revised up by +38k, bringing the final to +241k. The December report showed the fewest number of jobs added in three years, which almost certainly disappointed policymakers. However, it’s quite likely that extremely cold weather nationwide played a role—273k persons were away from work due to bad weather (far above average and the largest December figure since 1977, believe it or not). Weather was also responsible for a -16k decline in construction jobs (reversing November’s gain), but poor growth results were evident across a variety of areas. State and local government jobs also declined -11k, in a reversal of the prior trend. On the bright side, leisure/hospitality jobs grew +9k—albeit at a weaker rate than the prior month.

Conversely, the unemployment rate dropped from last month’s (and expected repeat of) 7.0% down to 6.7%. The participation rate played a large role for December, as that dropped two-tenths of a percent from 63.0% to 62.8%. Much has been made of the participation rate issue. Analysis from the Fed and others outline a scenario where a bulk of longer-term labor force erosion since participation last peaked in 2000 has been due to demographic factors (namely baby boomer retirements, which may account for up to half of the gap). At the same time, potential workers of ‘prime working age’ (25-54) also seem to be lagging in their workforce re-entry as well, coincident with an accelerated participation drop-off during the Great Recession. This is an ongoing area of mystery for economists, as no one seems to agree on the causes or solutions—as it’s likely a combination of factors. Average hourly earnings gained +0.1% for December, which was only half of the gain forecasted. The average workweek fell by 0.1 of an hour to 34.4, which could also be weather-related. In short, the extreme temperatures and weather put a dramatic damper on employment activity. The true test will be if an anticipated bounceback happens for January—in keeping with the decent job growth trend prior to December.

(0) Lastly, the FOMC minutes from the December meeting didn’t offer any surprises. For the most part, minutes don’t always offer great insights above and beyond the actual decision, but can provide additional some color as to committee sentiment. The discussion showed the taper was supported by ‘most’ members, while ‘many’ indicated that further reductions should happen in measured steps. Similarly, a ‘few’ members supported the lowering of the employment target from 6.5% down to 6.0%, so this could be interpreted as more of a controversial discussion point. There still appears to be some disagreement (inside and outside the FOMC) about both content/language and future usefulness of the Fed’s ‘forward guidance’ language concept. As discussed above, the labor force participation rate also appears to be a heavy discussion item—as to whether or not the weakness is cyclical or structural in nature. The committee appears to feel the decline is cyclical, implying continued monetary accommodation should be helpful in solving the problem. Rather, if it is structural, the monetary policy may end up being less effective.

Market Notes

Equities rebounded a bit from a rough first few days of the year, with a positive return.  Defensive health care and utilities led while materials and telecom lagged with negative outcomes on the week.  The 4th quarter earnings season got underway as usual with Alcoa posting mixed-to-negative results.  Retailers could be an especially interesting area to watch, with early indications for the holiday period looking a bit dicey to grim.

In foreign markets, European stocks gained 2% on the week, while Japanese and U.K. names were up just over a half-percent.  Southern Europe, namely Greece and Spain led, the latter due to service sector measures coming in with the best growth rate in over six years, which helped overall attitudes towards a recovery in the periphery.  The ECB kept rates steady (low), which also provided a sentiment boost, as did Mario Draghi’s continued accommodative language and acknowledgment of continued regional weakness.  Inflation below 1% in the Eurozone has been a mixed blessing in that regard (as it has in the U.S.).  Weakness was seen in Brazil, China and Eastern Europe in the emerging markets.  The IMF indicated that it expects to upgrade its outlook for the global economy in coming weeks; however, much stronger conditions in developed markets could come at the detriment of emerging market capital infusions—a problem in recent quarters.

Bonds had a much better week, with some interest rate relief.  In accordance with duration, long treasuries, TIPs and munis posted gains of a few percentage points, but all bond categories were in the positive.  As expected, short bonds and floating rate experienced the most tempered gains.  High yield bonds are continuing to experience strong investor inflows, which could sustain the positive trend, when coupled with the currently low default rate.

Commodities were largely down on the week.  Two of the few positive contracts were precious metals gold and platinum—two of 2013’s worst performing segments.  On the negative side were 10% declines in natural gas (in a correction to spikes related to the ‘polar vortex’ of early January and a less dramatic drawdown of inventory levels than expected), and crude oil, which fell to its lowest level since June of last year.

On a final note, one thing we find continually interesting is the number of strategists/commentators that have seemingly ‘come around’ over the past year or so—in many cases starting from a negative mindset of slowing-to-stagnant global growth, continued financial repression courtesy of the Federal Reserve and a ballooning debt load, as well as a societal and demographic decline, which should lead to mediocre-at-best risk asset returns.  Interestingly, as the market’s gains were great last year as sentiment from such bears began to turn bullish.  We shouldn’t be the least bit surprised by this, but as value investors, we can’t help but be interested.

Have a great week!